QE stands for Quantitative easing, A tranche of Monetary policy employed by Central Banks to Lower interest rates and in turn boost the economy. In short, this is achieved by the New money being used to buy financial assets likes bonds or Mortgage backed securities (MBS) which with a rising price forced on by the relentless buying will force the yield lower. A great article explaining more about QE can be found here by Scramble.
This method has been used a handful of times in economic history, notably by the Bank of Japan a decade ago when they faced the possibility of a Keynesian liquidity trap and deflation. However in the last 5 years it has been used by the US, UK, and the Eurozone.
In the US, there have been 3 rounds of QE, it first came about right after the financial crisis in late 2008 at which point the Federal Reserve started purchasing MBS’s. Alongside cutting the base rate to almost zero, it increased its balance sheet by around $1.4 Trillion. Then in late 2010 it came out with QE2 with an aim to buy $600 Billion of treasuries.
Most importantly is in the last few days – 13th September – the Federal Reserve announced “QE3”
"To support a stronger economic recovery and to help ensure that inflation, over time, is at the rate most consistent with its dual mandate, the Committee agreed today to increase policy accommodation by purchasing additional agency mortgage-backed securities at a pace of $40 billion per month."
This is the extract from the most recent Press release from the Federal reserve stating that they are going to purchase $40 Billion of MBS per month, it went on to say how combined with its already running operation twist, it hopes to lower interest rates
"These actions, which together will increase the Committee’s holdings of longer-term securities by about $85 billion each month through the end of the year, should put downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative."
The Press release data can be found here.Initial Effect:
In essence the Release of QE3 came around at the Jackson hole Symposium by Chairmen Ben Bernanke. Ever since then there has been a very definitive trend in financial markets.
As seen by this chart of EURUSD, ever since the Jackson hole symposium the USD has been heavily sold off against the EUR by about 600 pips. This is a very substantial move especially as it has broken many key resistance levels along the way with relative ease.
The reason for the USD to move lower due to QE is purely down to Supply and Demand. The Fed has increased the supply of USD by $40 billion with no new demand will of course lead to a decrease in the value of the USD.
Arguably the most effected instrument would be Gold / XAUUSD for many reasons.
- It is a dollar denominated asset and therefore if the Dollar falls, Gold will rise.
- Gold is a finite resource as opposed to fiat Currency.
- Gold is a Hedge against inflation and with the increase in money supply, inflation is likely and therefore gold will rise
- Finally, It is also a risk asset and therefore QE3 adds stability to the market allowing for risk flows to pick up and therefore raise the price of Gold.